Income elasticity of demand (YED)

Learning Objectives Calculate and interpret income elasticty

YED Measures the responsiveness of demand for a product following a change in consumers’ incomes

Income Elasticity of Demand Formula Income elasticity of demand (YED) measures the relationship between a change in quantity demanded and a change in real income YED = % change in demand % change in income

There are 3 different types of Income Elastic Goods Normal Goods Inferior Goods Luxury Goods

Income Elasticity of Demand: Normal Good – demand rises as income rises and vice versa Inferior Good – demand falls as income rises and vice versa

Income Elasticity of Demand Look out for the sign A positive sign (+) denotes a normal good A negative sign (-) denotes an inferior good

The details you need to know Income Elasticity of Demand The details you need to know Normal goods have a positive income elasticity of demand As consumers’ income rises, so more is demanded at each price level Normal goods have an income elasticity of demand of between 0 and +1 Luxuries have an income elasticity of demand > +1 So the demand rises more than proportionate to a change in income Inferior goods have a negative income elasticity of demand. Demand falls as income rises

+ Positive Income Elasticity A rise in income will cause a rise in demand A fall in income will cause a fall in demand Coffee example…. A 10% increase in income will result in a 2.3% increase in demand for coffee What’s the YeD? What will this look like on a graph?

Positive Income Elastic Demand Diagram Note the axes are DIFFERENT!

Elastic or Inelastic + YeD Elastic goods – are seen as LUXURIES OR SUPERIOR! Inelastic goods – are seen as NORMAL or NECESSITIES.

- Negative Income Elasticity An increase in income will result in a decrease in demand. A decrease in income will result in a rise in demand. ALSO known as INFERIOR GOODS

Negative Income Elasticity Potatoes are seen as a inferior product Potatoes have a YED of -0.48 So a 10% rise in incomes will result in? What would this look like on a graph?

Negative Income Elasticity Diagram = Inferior Note the different axes labels

Zero Income Elasticity This occurs when a change in income has NO effect on the demand for goods A rise of 5% income in a rich country will leave the Demand for toothpaste unchanged

+ + - Look for the signs! NORMAL GOODS LUXURY GOODS INFERIOR GOODS BETWEEN 0 & 1 +0.5 +0.9 + 0.1 GREATER THAN 1 +2 +5 +27 INFERIOR GOODS - CAN BE A DECIMAL OR A VALUE GREATER THAN 1

Income Elasticity of Demand For example: YED = - 0.6: Good is an inferior good but inelastic a rise in income of 10% would lead to demand falling by 6% YED = + 0.4: Good is a normal good but inelastic a rise in incomes of 10% would lead to demand rising by 4% YED = + 1.6: Good is a normal good and elastic a rise in incomes of 10% would lead to demand rising by 16% YED = - 2.1: Good is an inferior good and elastic a rise in incomes of 10% would lead to a fall in demand of 21%

Income Elasticity of Demand You decide…. Bus travel Cigarettes Designer clothes Fine wines Fresh vegetables Frozen vegetables Fruit juice Instant coffee International air travel Luxury chocolates Margarine Stilton Private education Private health care Stringy cheese Rail travel Shampoo Tinned meat Value “own-brand” bread

Relationship between Income and Quantity Demanded Zero income elasticity Quantity Negative income elasticity [inferior good] Positive income elasticity y1 Income y2